Definition:
A cap is a limit placed on how much an adjustable-rate mortgage (ARM) interest rate or payment can increase or decrease over a set period or over the life of the loan.

Example:
Suppose Rachel has an adjustable-rate mortgage initially at 4%, with a 2% annual cap. Even if market interest rates rise sharply, her rate can't exceed 6% in the first adjustment period. This protects her from a sudden, large increase in monthly payments.

Explanation:
In real estate, caps protect borrowers from extreme fluctuations in adjustable-rate mortgages. Common caps include periodic caps (limiting interest-rate changes each adjustment period), lifetime caps (limiting the total interest rate increase over the entire loan), and payment caps (limiting how much monthly payments can rise). These caps provide borrowers a measure of predictability and financial security, preventing unexpected and potentially unmanageable payment increases.

For example, a typical ARM might have a periodic cap of 2%, meaning the interest rate cannot rise more than 2% per year, and a lifetime cap of 5%, preventing the rate from ever rising beyond a certain total amount.

Importance:
Understanding caps is crucial for buyers considering adjustable-rate mortgages because they directly affect affordability and financial stability. Knowing these limits helps buyers evaluate risks, plan for future costs, and make informed borrowing decisions. Sellers benefit by clearly understanding mortgage features, enabling better guidance for potential buyers.

In short, caps provide essential safeguards, helping borrowers manage financial risk associated with fluctuating interest rates in adjustable-rate mortgages, ensuring predictable and manageable monthly housing payments.